Finding Gems Like Barnes & Noble

This morning the market was treated to news that Microsoft (MSFT) would be investing $300 million into the Nook eReader, Barnes & Noble's (BKS) profitable e-book reader. Microsoft will take a 17.6% stake in the soon-to-be-spun, fast-growing electronic book business, valuing it about $1.7 billion. Prior to this news, Barnes and Noble had a market cap $790 million. This morning shares are up nearly 90%.

My guess is that 99% of investors will not be treated to this market gain this morning when the check their portfolio (count me in the bottom 99%). The reason is because very few investors take the time to peel back the onion and see if there is more than meets the eye. By all accounts, Barnes and Noble was the sole retailer left in a declining industry. Thanks to Amazon (AMZN), very fewer people are buying books at bookstores when you can save as much as 60% buying the same book online. For a company like Barnes and Noble that was stuck with the added pain of expensive real estate costs, the writing was clearly on the wall. As a result, very few looked at Barnes and Noble long enough to discover the value of the Nook eReader business.

For $300 million, the investment was a no-brainer for Microsoft. With the signing of the deal, Microsoft now has become a very real challenger to Amazon's Kindle business and the iPad tablet. Three hundred million is a negligible amount of money for Microsoft and a brilliant move that now gives the company an option into a very lucrative marketplace.

The deal with Barnes and Noble got me thinking about other businesses with similar characteristics, where the overall business prospects look terrible and as a result the market cap could be discounting a possible hidden gem or other value-creating transaction. To be sure there are going to be a lot more strikeouts than there are Barnes and Noble like home runs. Nonetheless, as is evident today, a transaction like the Microsoft/Barnes and Noble deal is irrespective of economic conditions or unemployment rates.

The easiest comparison today is the step cousin to Barns and Noble, Best Buy (BBY). Like BKS, Best Buy is finds itself competing as a big box retailer in an business that is rapidly going online. Many people are using Best Buy to examine merchandise only to turn around and order it online for 30% less. Best Buy can not compete with that. Not to mention that high-growth categories like smartphones, tablets and notebook computers require very little physical space to sell. Shares in Best Buy are trading at $22, valuing the business at $7.8 billion. The old CEO is out. If shares continue to decline, a distinct possibility considering the outlook remains weak, pay attention.

Research in Motion (RIMM) is another struggling business that could one day surprise investors. While the Blackberry smartphone continues to lose ground with consumers, RIMM has a valualbe corporate business and some decent technology that the big boys may want. At a current EV of $5.4 billion, the price tag may still be a bit on the high side. But it that valuation goes a little lower, there are plenty of tech titans who can quickly write a multi-billion dollar check without skipping a beat.

Then there is Rentech (RTK), a clean energy business that has had limited commercial success on that front. But where they company has been enormously successful is the fertilizer business. Last year, Rentech spun out Rentech Nitrogen Partners (RNF) to enormous success. Today RNF trades for $30 and has a market cap of $1.2 billion. Rentech kept 60% of Rentech Nitrogen, a stake worth $720 million. When I first recommended RTK it was trading for around $1.70. Today it trades for $2.30, or a market value of $521 million, a significant discount to the value of the nitrogen stake. Moreso, as Rentech Nitrogen begins to make cash distributions to unit holders, Rentech will collect 60%.